The competent departments of the Croatian National Bank have completed the first part of the report on the losses in the foreign exchange operations of Riječka banka d.d., Rijeka, incurred from 1998 to February 2002. So far, the CNB examiners have analyzed the period from 1997 to the end of the first half of 2000. Their preliminary findings are largely consistent with the initial discoveries, already known to the public, about the amount of losses and the way they were made and covered up.
The official documentation of the bank, as well as the examination of foreign banks' balances as of 15 March 2002, have shown that the transactions of the Foreign Exchange Market Division of Riječka banka resulted in losses to the amount of USD 99,042,001, which is the equivalent of HRK 828, 961,545. Exactly one third of this amount, USD 33,907,126, relates to the losses incurred in the period covered by the first part of the report. The analysis of the bank's documentation and other related materials has demonstrated that the incurred losses were covered up in the following ways:
- by recording nonexistent deposits in bank assets,
- by closing opened exchange arbitrage transactions and opening new ones,
- by overdue settlement of open exchange arbitrage;
- by unauthorized taking of foreign exchange deposits, and
- by recording exchange arbitrage at an incorrect value date.
The losses mainly resulted from performing exchange arbitrage transactions. These are more risky than the regular ones (which involve buying currencies for payment operations or for changes in the currency structure of foreign exchange portfolios), because they comprise two or more purchases and sales of foreign exchange, which are supposed to be closed within a day, and are based on the speculations that the movements in the exchange rate in the period between the opening and closing of these transactions will result in a profit. Naturally, wrong estimates may result in losses. Foreign exchange may be purchased and sold through spot transactions (where the purchased currency has to be delivered within two working days from the conclusion of the transaction) or forward transactions (where the delivery time is longer and the date, type, amount and price of the foreign exchange is fixed).
Until 1996, Riječka banka has mainly performed regular arbitrage. That year, however, exchange arbitrage transactions, valued between USD 50,000 and 5,000,000 each, became more frequent. In 1997, a number of exchange arbitrage transactions amounted to USD 10,000,000 each, to reach as much as USD 100,000,000 in the period between 1998 and 2002.
On 28 June 1999, the Management Board of Riječka banka enacted a decision on imposing restrictions in these operations. Accordingly, individual dealers were prohibited from conducting transaction exceeding 2% of the bank's regulatory capital. The head of the bank's Foreign Exchange Market Division was authorized to conduct transactions to the value of up to 10% of the bank's regulatory capital. The total open position of the bank was limited at USD 50,000,000, while all opened transactions had to be closed within the same day. These restrictions were not included in the agreements on the so called "margin accounts" that the Chairman of the Riječka banka Management Board concluded with some foreign banks, which enabled the main dealer of Riječka banka to trade in much larger amounts.
The analysis has shown that the losses were covered up by recording nonexistent deposits, which were closed by debiting the unsettled exchange arbitrage at year-end, as well as at the end of shorter calculation periods. Moreover, to conceal the unusual fluctuations in deposit balances at the time of closing nonexistent deposits and opened exchange arbitrage transactions, that would have been revealed while compiling financial statements, real deposits were made, in the same currency, to the same amount and, most frequently, within the same time limits, without being entered into the records of the Foreign Exchange Market Division.
In addition, numerous complaints related to the transactions of the Foreign Exchange Market Division were not adequately circulated within the bank and therefore not taken as a warning signal. Without an insight into the source documents, the Analytical Bookkeeping Department controllers were unable to establish that credits or debits to the accounts were incorrectly entered into the business books. However, they made numerous written complaints indicating that business operations in the Foreign Exchange Asset Department did not provide for a prompt recording of business operations.
Ten examiners in Riječka banka are in charge of internal control and audit. As shown by the documentation, they regularly examined the bank's foreign exchange deposit balances, but not exchange arbitrage transactions. The examination conducted in February 2002, at the request of a member of the Management Board responsible for foreign exchange operations, covered 2001, but no irregularities were established. It was only in early March this year that another examination, prompted by the List of Completed Exchange Arbitrage Transactions, received from the Standard Chartered Bank London, revealed irregular, inaccurate, deficient and false records. Out of 123 examined transactions from the List (the remaining 14 were not examined owing to the illegibility of data) 50 were neither recorded in the bank's documentation nor in foreign banks' statements. Of 73 transactions recorded in foreign banks' statements and bookkeeping records, only three had been provided with source documents and listed among the exchange arbitrage transactions conducted from 1 to 15 January 2002.
On 30 March 1999, the Croatian National Bank notified the Management Board of Riječka banka of the first anonymous complaint. However, the Board failed to request a special examination of these operations. Following the second complaint and repeated notification by the Croatian National Bank, of 28 January 2002, a special examination was carried out, but no irregularities were established in the operations of the Foreign Exchange Market Division.
KPMG Croatia d.o.o. audited the bank's operations in the last two business years and Coopers&Lybrandt in the previous periods. The KPMG audit report of 12 February 2002 confirmed that the financial statements of Riječka banka as of 31 December 2001 gave a true and fair view of the bank's performance. Having been notified, on 4 March 2002, of the discovered bank's liabilities that were not entered into the bookkeeping records, KPMG experts visited the bank from 8 to 10 March. On 12 March KPMG notified the CNB of possible irregularities in the operations of Riječka banka and withdrew their previous audit report. On 13 March, they provided the Bayerische Landesbank Girozentrale, then the majority owner, with a preliminary draft report on the investigation of fraudulent activities in the Foreign Exchange Asset Department of Riječka banka. KPMG also performed due diligence prior to the purchase of the majority share in the bank, in cooperation with Delloitte&Touche. At the request of the bank, KPMG only confirmed three balances of foreign exchange deposits as of 30 September 2001, but it is not certain for how many more balances the information had been required. Upon the establishment of the irregularities in the foreign exchange operations of Riječka banka, two experts from Bayerische Landesbank (an internal auditor and a SWIFT expert) spent almost two days in the bank. The central bank has not been informed of their findings. It should be noted that no improvements have been made in the foreign exchange operations of Riječka banka since Bayerische Landesbank became the majority owner.
The Croatian National Bank has decided to make public the entire report on the on-site examination conducted in Riječka banka, in view of an exceptional interest of professional and political circles, as well as the general public, in the events related to the bank. The report is also intended to be a warning to other financial institutions engaged in similar business operations, particularly as concerns the organization and consistent implementation of their own control mechanisms.
The central bank expects that the overall report will be completed by the end of the year and it will be made available to the public.